Last updated: 17:41 / Friday, 27 September 2013
Strategy by Threadneedle

A Turn Towards Domestic Consumption and National Players

A Turn Towards Domestic Consumption and National Players

The UK and Europe have been late in joining the party to celebrate economic recovery, but signs of this happening are now getting stronger. In the UK, we still see pretty strong headwinds, but the loose monetary policy appears to be working, and the government’s initiatives to boost the housing market are also taking effect. Initially, the recovery appeared to be very consumption-biased, but now appears more broadly based. Recent manufacturing surveys have been strong, and the upward revision to second- quarter GDP was due to better-than-estimated exports and business investment. Meanwhile, PPI claims of around £10bn have certainly helped encourage consumers to spend. Additional support should come from the likely return of around £50bn in cash and shares to Vodafone shareholders, as a result of the sale of the company’s stake in Verizon Wireless. Similarly, the Eurozone remains burdened by a very weak trajectory for government debt and continued bank deleveraging. Manufacturing surveys have strengthened, however, pointing to useful growth, and news from the periphery has improved, assisted by some pushback against austerity.

In the US, where growth has been established for longer, the news has been a little more mixed. The healthy recovery in the housing market may now find the going heavier because of rising mortgage rates, following the rise in government bond yields. In addition, the expected pick-up in capital expenditure by companies is proving more elusive than expected, despite strong balance sheets and aged equipment.

In Japan, Abenomics has certainly had an effect in kick-starting activity. Shinzo Abe has promised a “three arrow” policy, the first two being monetary and fiscal injections. Arrow three consists of a number of specific policies to support growth. This is the part of the package that has yet to materialize in a meaningful way. Markets are looking for activity in this respect, in order to avoid disappointment.

In emerging economies, regions have been moving in different directions. Outflows of capital, following talk of tapering in quantitative easing by the US Federal Reserve, have led to currency weakness, particularly in regions with weak trade and budget positions. This has prompted the authorities to tighten monetary policy to defend currencies, which is impeding growth. In contrast, reports from the all- important Chinese economy have improved a little, with retail sales, trade and manufacturing data above the levels anticipated.

In light of the generally improved outlook for growth in developed economies, we have looked favorably towards companies with domestic exposure in economically-sensitive areas. In Europe, in particular, we have had pretty defensively-positioned portfolios, but have recently added to domestic players, largely through banks, autos and cable companies. In the UK, we had substantial positions in housing-related areas. These stocks have enjoyed strong performance, however, and are already discounting a good recovery. We have therefore looked at adding to defensive growth stocks, which have been overlooked in recent months. In the US, we also favor stocks driven by domestic consumption; again, though, housing-related stocks appear to be reasonably fully valued.

We have long been cautious of core government bonds. We retain that position, but are starting to see better value after a significant rise in yields. The short end of curves appears to offer the best value, discounting official rates rising at a faster pace than we anticipate. The 30-year end of the US treasury market also offers reasonable value. Around the 10-year level, however, we see some further upside in yields against the background of a tapering of quantitative easing and strengthening global growth.

Equities remain our preferred asset class. Valuations are no longer cheap but are still reasonable. Tapering is clearly a potential headwind, but economic recovery is a useful support. Furthermore, the M&A market has recently come to life with some very substantial deals in the telecom, IT and media sectors.

Opinion column by Mark Burgess, Chief Investment Officer at Threadneedle